Sentiments, Financial Markets, and Macroeconomic Fluctuations

45 Pages Posted: 9 Feb 2015 Last revised: 18 Sep 2016

See all articles by Jess Benhabib

Jess Benhabib

New York University - Leonard N. Stern School of Business - Department of Economics; National Bureau of Economic Research (NBER)

Xuewen Liu

University of Hong Kong (HKU) - Finance Area, Faculty of Business and Economics

Pengfei Wang

HKUST, Department of Economics; Hong Kong University of Science & Technology (HKUST) - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: February 1, 2015

Abstract

This paper studies how financial information frictions can generate sentiment-driven fluctuations in asset prices and self-fulfilling business cycles. In our model economy, exuberant financial market sentiments of high output and high demand for capital increase the price of capital, which signals strong fundamentals of the economy to the real side and consequently leads to an actual boom in real output and employment. In a two-country setting, our sentiment-driven fluctuations help explain global recessions and the cross-country comovement puzzles. In the extension to the dynamic OLG setting, our model demonstrates that sentiment shocks can generate persistent fluctuations in output and employment, holding the promise to explain persistent business cycle fluctuations.

Keywords: Sentiments, Asset Prices, Feedback, Real Economy, Self-fulfilling Equilibrium

Suggested Citation

Benhabib, Jess and Liu, Xuewen and Wang, Pengfei, Sentiments, Financial Markets, and Macroeconomic Fluctuations (February 1, 2015). Journal of Financial Economics (JFE), Vol. 120, No. 2, 2016, Available at SSRN: https://ssrn.com/abstract=2562067 or http://dx.doi.org/10.2139/ssrn.2562067

Jess Benhabib

New York University - Leonard N. Stern School of Business - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Xuewen Liu

University of Hong Kong (HKU) - Finance Area, Faculty of Business and Economics ( email )

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China

HOME PAGE: http://web.hku.hk/~xuewenl/

Pengfei Wang (Contact Author)

HKUST, Department of Economics ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

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